28/36 rule

cbee817 · May 2014

I went a financial seminar at work today and the speaker mentioned a 28/36 rule that I never heard of. He said that theoretically, 28% of monthly income should go to your house/rent and 36% should cover all monthly debt payments (student loan, credit cards, cars, etc).

I checked my numbers from 2008 through current- 2013 and 2014 (projected) are the only years that we hit the combined 64% or less. I did not factor in day care as debt.. if I did, we would be way over.

What does MM think about this rule?

smerka · May 2014

I think 36% is a ridiculous amount of money to be paying on debt. Especially if it's not mortgage debt.

hoffse · May 2014

cbee817 said:

I went a financial seminar at work today and the speaker mentioned a 28/36 rule that I never heard of. He said that theoretically, 28% of monthly income should go to your house/rent and 36% should cover all monthly debt payments (student loan, credit cards, cars, etc).
I checked my numbers from 2008 through current- 2013 and 2014 (projected) are the only years that we hit the combined 64% or less. I did not factor in day care as debt.. if I did, we would be way over.

What does MM think about this rule?

**STUCK IN THE BOX

That "rule" is calculated using gross income, not take-home. H and I won't follow this. Our housing/mortgage debt will be far less than our student loan debt. So we will be upside down on that rule.

That said - it's just a guideline to spend less than you make. This is one of those formulas banks will sometimes use to decide if you can "afford" a house or not. Of course, we all know that the banks are usually really optimistic about how much is actually affordable.

A safer guideline is to use your net income, rather than your gross, as the basis for calculation. Then you should have plenty to spare.

cbee817 · May 2014

@hoffse.. it's weird that a rule like this would apply to gross, but I'm glad to hear that it does. Does anyone think about expenses based on their gross income?

hoffse · May 2014

One other thing about this - it changes as your income goes up.

For instance - spending 50% of your net income on debt seems crazy. But it's a lot less crazy if you bring home $20,000/month than if you bring home $4,000/month. Scenario A leaves you with $10K/month left over for "everything else." Scenario B leaves you with $2K - that's a lot tighter for "oh crap" months.

So it's all relative. Many people with jumbo mortgages for very very expenses houses are over these guidelines, but they also make so much money that it doesn't really matter (so long as their incomes stay the same).

ashleyjesse1112 · May 2014

To me that's a high ratio for just debt - 64%! That's not even including any of the other bills that aren't considered debt. I just calculated what our total expenses (minus any spending/fun money) will be (we are buying a house) compared to our net monthly and it will be 47%. I couldn't imagine having 64% in total debt and then all the other bills - phone, internet, cable, gas, car insurance, food, etc... Ah! That sounds scary!

hoffse · May 2014

Maybe I'm wrong, but I thought the rule was 28% for house, 36% TOTAL - not 64% total. If your debt was 64% of your gross income, many people wouldn't have enough to pay their taxes.

cbee817 · May 2014

hoffse said:

Maybe I'm wrong, but I thought the rule was 28% for house, 36% TOTAL - not 64% total. If your debt was 64% of your gross income, many people wouldn't have enough to pay their taxes.

When I looked at our numbers, I based everything off of net income.. just because our taxes, 401K, DH's 403B, health insurance, FSA for daycare are all deducted for us.
For this year, our mortgage (principle, interest, escrow) and utilities (gas, electric, water, cell) make up 20% of our take home pay.
I have our debt part at 44% and it's all credit cards (we have no student loans, car loans, personal loans, etc) which for us includes cable and internet bill, groceries, gas, clothes, toiletries, stuff for the girls, car repairs, car insurance, home repairs- we charge pretty much everything and pay the bill in full every month.
The 2 things I did not include as debt were day care (20% of our take home pay) and misc checks I write throughout the year (birthdays, weddings, donations, life insurance- basically anything I can't use a credit card for- about 2%).
The balance of our take home pay is used for Roth IRAs, vacation fund, and savings (14%).
That's how I interpreted the 28/36 rule, but it may not be right at all.

lifeonthehill · May 2014

These numbers terrify me and remind me of why I want of debt ASAP.

When we got married my family told us to only only use 25% for rent, Save 15% for retirement, Save 10% for other funds(vacation, baby fund, e fund and ins. deductible), 5% to tithing and live off of the rest.

Xstatic3333 · May 2014

I have heard this rule. I like to use these numbers with our take-home income to create extra buffer room. Doing it that way we're still just barely good, but I always have to remind myself to use the min payments since we tend to overpay anything over 6% interest (currently my SL and H's car).

hoffse · May 2014

Xstatic3333 said:

I have heard this rule. I like to use these numbers with our take-home income to create extra buffer room. Doing it that way we're still just barely good, but I always have to remind myself to use the min payments since we tend to overpay anything over 6% interest (currently my SL and H's car).

Yes I think doing it with net income - vs. gross - is much better. When you use gross it just doesn't leave enough buffer for retirement, IMO, at least not until you get into serious income levels where the extra expense of your debt just doesn't matter so much.

EDIT: The best "rule" would be to determine savings based on a percentage of your gross income and debt based on a percentage of your net. I might have to look into doing it that way...

formerlyGDaisy09 · May 2014

I've heard this, but the housing portion includes mortgage, insurance, utilities, and I've even heard car payment lumped in there. The debt part seems really high though.

Mom987 · May 2014

That sounds like a lot of debt. We pay 21% takehome on our mortgage and are debt free. Whenever I say that it reminds me we need to really he saving more and paying down the mortgage more.

Wulfgar · May 2014

I am thinking what they mean is that your total house costs should be less than 28% of your budget this includes taxes, insurance, and key utilities such as water, gas, electric. Then a total of 36% in debt and housing to give you the room to cover everything else you need.

A lot also depends on where you are at on your career path. I am just really starting on mine so I am willing to have a little higher current debt level while paying off mine and MW's student loans. A decade from now I am hoping to have most of my debts paid off and few new ones.

maple2 · May 2014

cbee817 said:

hoffse said:

Maybe I'm wrong, but I thought the rule was 28% for house, 36% TOTAL - not 64% total. If your debt was 64% of your gross income, many people wouldn't have enough to pay their taxes.

When I looked at our numbers, I based everything off of net income.. just because our taxes, 401K, DH's 403B, health insurance, FSA for daycare are all deducted for us.
For this year, our mortgage (principle, interest, escrow) and utilities (gas, electric, water, cell) make up 20% of our take home pay.
I have our debt part at 44% and it's all credit cards (we have no student loans, car loans, personal loans, etc) which for us includes cable and internet bill, groceries, gas, clothes, toiletries, stuff for the girls, car repairs, car insurance, home repairs- we charge pretty much everything and pay the bill in full every month.
The 2 things I did not include as debt were day care (20% of our take home pay) and misc checks I write throughout the year (birthdays, weddings, donations, life insurance- basically anything I can't use a credit card for- about 2%).
The balance of our take home pay is used for Roth IRAs, vacation fund, and savings (14%).
That's how I interpreted the 28/36 rule, but it may not be right at all.

I am not familiar with the rule, but I would really need to better understand the debt aspect, particularly with respect to credit cards. What you describe above for your credit card use is not something I personally would consider debt. Those are just monthly expenses that you happen to use a credit card to pay. I would only consider it debt if you carried a balance from month to month because you could not pay it in full. So, in your case I would only consider your mortgage payments as debt when seeing how you measure up to this rule of thumb.

Xstatic3333 · May 2014

I'm also curious whether "debt" includes monthly bills like utilities and phone. I've been assuming it doesn't. I know many consider utilities as part of housing costs, but I tend to separate them mentally since they vary so wildly by season here.

brij2006 · May 2014

I've always been under the assumption that the 25% rule for your house means the mortgage, taxes, insurance, and utilities.

Then for "debt" I would definitely not use that percentage. Think about it. That's 64% of your pay (I'm assuming they're talking net) designated solely to "payments" every month. That leaves you with 36% left. Invest your 15% and tithe the 10%, then it leaves you with only 11% left to save up for things, buy groceries, clothing, and entertainment. No thank you!

hoffse · May 2014

Ok I think people are getting confused. I'm fairly positive that this rule is:

28% of GROSS INCOME for mortgage, taxes, insurance (basically what you pay the bank and escrow).

36% of GROSS INCOME for all debt total - car debt, student loan debt, credit card debt, and your mortgage debt above.

Theoretically that should leave most people with enough for taxes, retirement, and basic spending (whether this spending goes on a CC or not is irrelevant, so long as you are paying it off in full each month). The problem is that the buffer leftover is typically not sufficient for lots of extra savings too, at least not for most middle class folks.

If you happen to have a really high income, then sure this amount of debt - as calculated by your gross income - might be perfectly workable to allow you to spend (relatively) freely and still have additional savings on top. But a better plan for most people is to adjust these figures by considering your net or "take-home" after your taxes, retirement, etc. is taken out. If you are at 36% of your NET income for all debt, and your taxes and retirement are also funded too, then you have 64% of your take-home left for your groceries, your gas, your utilities, your general spending, and your "extra" savings. That ought to be perfectly affordable for the vast majority of people.

brij2006 · May 2014

I think in our situation we do just about everything with our "net" income except for investments. That is 15% of our "gross."

Haha. I just ran the numbers. If we do our mortgage, taxes, and insurance on our gross income, then it is only 8.6% of our income. I can't even imagine having our house be 28% of our gross income, but I'm also pretty conservative. It would mean our mortgage payment would have to be $2,100 a month. There's no way we would be able to make that happen and still meet our other goals.

These are the percentages that I think a lot of people get wrapped up in. "Someone told me my house should be 28% of my gross income, so I'm going to buy one that the payment is 28% of what I make before taxes." Then a few years later they wonder why they can't make ends meet yet can't sell their house because they're under water on it. Then they say that it's the markets fault. No, you listened to 1 person who said your house should be 28% of your income and that was way too high. I can't even fathom how we would make it with a $2,100/month mortgage payment.

KatieCutie05 · May 2014

LMAO- Wow I like this theory cus then it means i'm actually doing good!

Ya know i mean except for the fact that i'm not and i'm broke. thats gotta be the worst theory ever. i've heard something similar before and it really makes me angry that anyone would actually be stupid enough to even suggest that someone be as broke as me. .

36% to all non mortgage debt? I "only" pay 31% so i guess that means i'm good. Um 800 to student loans and two car loans totalling 680.... oh yea and that makes my debt load close to double my yearly household income but hey these so called financial guys say thats good. because my payments are less then 36% But then i guess i can comfortably afford to pay 1,710 instead of 1,480. hahahah

28% to mortgage and escrow? Right now we "only" pay 18%... so according to this I can afford a mortgage of 1330 instead of 850...

That would leave us with 1,700 for everything else... Food, gas, spending, saving, giving.... Um i guess that means i'm supposed to eat ramen noodles, walk to work, and never save or give a dime... this plan is more like the "how to be poor and end up on foodstamps" plan. moronic. just plain moronic. How these people have a degree in finance and still recommend that just amazes me.

hoffse · May 2014

KatieCutie05 said:

LMAO- Wow I like this theory cus then it means i'm actually doing good!

Ya know i mean except for the fact that i'm not and i'm broke. thats gotta be the worst theory ever. i've heard something similar before and it really makes me angry that anyone would actually be stupid enough to even suggest that someone be as broke as me. .

36% to all non mortgage debt? I "only" pay 31% so i guess that means i'm good. Um 800 to student loans and two car loans totalling 680.... oh yea and that makes my debt load close to double my yearly household income but hey these so called financial guys say thats good. because my payments are less then 36% But then i guess i can comfortably afford to pay 1,710 instead of 1,480. hahahah

28% to mortgage and escrow? Right now we "only" pay 18%... so according to this I can afford a mortgage of 1330 instead of 850...

That would leave us with 1,700 for everything else... Food, gas, spending, saving, giving.... Um i guess that means i'm supposed to eat ramen noodles, walk to work, and never save or give a dime... this plan is more like the "how to be poor and end up on foodstamps" plan. moronic. just plain moronic. How these people have a degree in finance and still recommend that just amazes me.

Actually this is used by banks pretty much everywhere across the country. Obviously it's not a good formula for a lot of people, but it's what you will typically be approved for with good credit when you are applying for a mortgage. That's why a lot of people blame the banks for the mortgage crisis.

I'm pretty sure banks consider retirement/savings optional - and that's why the numbers are so high when you figure it using gross income. If you were literally just paying your taxes, sticking to these figures for debt, and then spending the rest on your living expenses - well sure, most of us could live on what was left without accumulating more debt. We could even make small contributions to retirement if we opted to. In theory. Once you add savings at the appropriate levels, though, the numbers get all out of whack for most people.

KatieCutie05 · May 2014

o wait this is supposed to be BEFORE taxes??? in that case someone call obama and tell him i can't afford to pay my taxes... 25% plus 28% plus 36% would leave me with 11% to save, eat, tithe, get to work,pay for health insurance.... If we recomend this to the world pretty soon we're going to have to up the poverty level to 100k a year income.

maple2 · May 2014

KatieCutie05 said:

o wait this is supposed to be BEFORE taxes??? in that case someone call obama and tell him i can't afford to pay my taxes... 25% plus 28% plus 36% would leave me with 11% to save, eat, tithe, get to work,pay for health insurance.... If we recomend this to the world pretty soon we're going to have to up the poverty level to 100k a year income.

If hoffse is correct, the recommended allocation would be 25% for taxes, 28% for housing, and 8% for other debt (36% total debt payments) leaving 39% for other savings and monthly expenses. (That's assuming your effective tax rate is 25% not just that you are in the 25% tax bracket since not all income is taxed at the same rate.) It still might not be a great recommendation for people who want to save for retirement, college, etc., pay other monthly bills, and make charitable contributions, but it's not quite as outlandish as 11%

athlete010688 · May 2014

KatieCutie05 said:

LMAO- Wow I like this theory cus then it means i'm actually doing good!

Ya know i mean except for the fact that i'm not and i'm broke. thats gotta be the worst theory ever. i've heard something similar before and it really makes me angry that anyone would actually be stupid enough to even suggest that someone be as broke as me. .

36% to all non mortgage debt? I "only" pay 31% so i guess that means i'm good. Um 800 to student loans and two car loans totalling 680.... oh yea and that makes my debt load close to double my yearly household income but hey these so called financial guys say thats good. because my payments are less then 36% But then i guess i can comfortably afford to pay 1,710 instead of 1,480. hahahah

28% to mortgage and escrow? Right now we "only" pay 18%... so according to this I can afford a mortgage of 1330 instead of 850...

That would leave us with 1,700 for everything else... Food, gas, spending, saving, giving.... Um i guess that means i'm supposed to eat ramen noodles, walk to work, and never save or give a dime... this plan is more like the "how to be poor and end up on foodstamps" plan. moronic. just plain moronic. How these people have a degree in finance and still recommend that just amazes me.

This is me as well! According to this theory, our mortgage (house payment, taxes, insurance) is 18.5% of our gross pay. It's saying we could afford a mortgage of almost $2000! Yeah, definitely not!

Then...our mortgage + 2 car payments (only for another month or two) + medical bill puts us at 28% of our gross income.

I already feel like we're broke and don't have any money! I couldn't imagine using those numbers plus being able to live.

brij2006 · May 2014

hoffse said:

KatieCutie05 said:

LMAO- Wow I like this theory cus then it means i'm actually doing good!

Ya know i mean except for the fact that i'm not and i'm broke. thats gotta be the worst theory ever. i've heard something similar before and it really makes me angry that anyone would actually be stupid enough to even suggest that someone be as broke as me. .

36% to all non mortgage debt? I "only" pay 31% so i guess that means i'm good. Um 800 to student loans and two car loans totalling 680.... oh yea and that makes my debt load close to double my yearly household income but hey these so called financial guys say thats good. because my payments are less then 36% But then i guess i can comfortably afford to pay 1,710 instead of 1,480. hahahah

28% to mortgage and escrow? Right now we "only" pay 18%... so according to this I can afford a mortgage of 1330 instead of 850...

That would leave us with 1,700 for everything else... Food, gas, spending, saving, giving.... Um i guess that means i'm supposed to eat ramen noodles, walk to work, and never save or give a dime... this plan is more like the "how to be poor and end up on foodstamps" plan. moronic. just plain moronic. How these people have a degree in finance and still recommend that just amazes me.

Actually this is used by banks pretty much everywhere across the country. Obviously it's not a good formula for a lot of people, but it's what you will typically be approved for with good credit when you are applying for a mortgage. That's why a lot of people blame the banks for the mortgage crisis.

I'm pretty sure banks consider retirement/savings optional - and that's why the numbers are so high when you figure it using gross income. If you were literally just paying your taxes, sticking to these figures for debt, and then spending the rest on your living expenses - well sure, most of us could live on what was left without accumulating more debt. We could even make small contributions to retirement if we opted to. In theory. Once you add savings at the appropriate levels, though, the numbers get all out of whack for most people.

That is exactly why there needs to be classes teaching this stuff to High School and College students. Heck, even our generation and our parents generation too. People need to be advocates for themselves when it comes to money. You live this theory and you will live broke the rest of your life.

I just had a disagreement the other day, with a friend who is a mortgage lender. She tried telling me that we will never be able to buy a house again without a credit score. When I said, "so you're telling me if we paid cash for our next house (which we plan to), we wouldn't be able to buy it because we have $200k in our hands but no credit score? She was quiet and said, "well people still need a credit score." For what? To prove that you can take out debt, so you can have a company give you even more debt? Congratulations! Be an advocate for yourself and be smart with your money. Be patient and you will be able to have things without restrictions like PMI insurance, playing the game with a CC for a credit score, or buying a car or house you don't like because it fits within the amount they tell you that you can spend.

hoffse · May 2014

maple2 said:

KatieCutie05 said:

o wait this is supposed to be BEFORE taxes??? in that case someone call obama and tell him i can't afford to pay my taxes... 25% plus 28% plus 36% would leave me with 11% to save, eat, tithe, get to work,pay for health insurance.... If we recomend this to the world pretty soon we're going to have to up the poverty level to 100k a year income.

If hoffse is correct, the recommended allocation would be 25% for taxes, 28% for housing, and 8% for other debt (36% total debt payments) leaving 39% for other savings and monthly expenses. (That's assuming your effective tax rate is 25% not just that you are in the 25% tax bracket since not all income is taxed at the same rate.) It still might not be a great recommendation for people who want to save for retirement, college, etc., pay other monthly bills, and make charitable contributions, but it's not quite as outlandish as 11%

Yes. This. It's possible, but not recommended, given that you really should be putting away at least 15% gross for retirement, without counting other savings too. So after retirement you are left with 24% for everything else. H and I try to contribute 20% to retirement, so we would be left with 19%. That's cutting it too close for us - we like to have additional savings each month.

I agree with Brij - people need to educate themselves about how all of this works. I wish there was a personal finance and civics course required before graduating from high school...

Xstatic3333 · May 2014

Yikes, just did the math on what 28% of our gross is, and it's pretty crazy. 2,000 on housing! That's bonkers. Now, our other debt is a higher percentage than this formula recommends so housing needs to be lower anyway, but man that's high.

The thing with retirement being optional is that for us, it's not. 9% of H's salary goes straight to a pension fund that he'll need to H's his job for 20 years to be vested in (grumble grumble). I know many are in the same situation.

vlagrl29 · May 2014

our mortgage is really DH's studio rent for is photography studio and that is $1100 per month so I guess that seems about right regarding the 28%

brij2006 · May 2014

AprilH81 said:

I was bored and playing on Yahoo reading articles and I came across this article. Timely piece based on this discussion.

https://homes.yahoo.com/news/what-3-assurances-lenders-look-at-when-buying-a-house-000307320.html

Wow! I can't even imagine how many first time homebuyers read articles like this. Recommending you borrow from a 401k or an IRA to get a 20% down payment. That's insane.

It shows a lot of money management and will when someone has a 20% down payment that they saved up to have and didn't borrow from elsewhere. If only that showed for something.

Xstatic3333 · May 2014

I was struck by FHA not counting deferred student loans in your DTI! That seems like a recipe for disaster to me.

hoffse · May 2014

Xstatic3333 said:

I was struck by FHA not counting deferred student loans in your DTI! That seems like a recipe for disaster to me.

Our government at work!

It's really interesting how matter of fact they are about it, isn't it? My one (and only) shred of hope in all of this is assuming that the majority of people probably don't know the difference between gross income and net income - I would bet that most average folks reading that article would assume they are calculating it based on your take-home.

Of course, then the bank is all "Congrats! You can afford a $500,000 house!" and their eyes get big with all the possibilities.

Seriously, H and I are struggling with this decision right now - buy at the top of our budget for a "forever" house? Or buy something that gets us in the market with a roof over our heads to pay down debt, knowing we will outgrow it in the next 5-7 years? We definitely know the responsible choice, but I'm not going to lie - it's not the choice we WANT to make. Granted, our "top" budget is nowhere close to what the bank would be willing to loan us.

28/36 rule

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